After Liberty Reserve Shut Down, Is Bitcoin Next?

The world's financial system ought to stop criminals from dealing drugs, funding terrorism, and skipping out on taxes. But somehow, all those things keep happening.

The Wall Street Journal reports one place that won't happen anymore is Liberty Reserve -- the provider of anonymous virtual money transfer services "virtually all" of whose $6 billion worth of transfers in 55 million transactions by a million users were done to launder illegal activities, according to Manhattan U.S. attorney, Preet Bharara.

The Treasury Department set a precedent in using the 2001 Patriot Act against a virtual currency to sever the link between Liberty Reserve and the U.S. financial system.

And the list of criminals allegedly aided by Costa Rica-based Liberty Reserve is broad. According to the indictment, it includes "traffickers of stolen credit card data and personal identity information; peddlers of various types of online Ponzi and get-rich-quick schemes; computer hackers for hire; unregulated gambling enterprises; and underground drug-dealing Web sites."

And at least one of the eight alleged participants used Liberty Reserve to launder some of his ill-gotten gains from the scheme to steal $45 million from New York City ATM machines using prepaid debit-card numbers, according to the Journal.

Liberty Reserve's system for converting illegal profits into funds available through the legal part of the financial system was complex. According to the Journal, prosecutors allege that Liberty Reserve allowed criminals to conduct illegal transactions through a digital currency called LR.

Criminals would open an account using a false name and address without even trying to appear legitimate -- prosecutors gave examples of "criminal monikers such as Russia Hackers or HackerAccount," reports the Journal.

The Liberty Reserve account holder would then wire, say, dollars to "approved third-party currency exchangers" based in places like Malaysia, Russia, Nigeria and Vietnam, according to the New York Times, that would convert the dollars into LRs and deposit them in his account.

He could then, say, buy stolen credit-card numbers by transferring the LRs to the seller's Liberty Reserve account and the seller could use an approved third party currency exchanger to convert the LRs back into dollars.

In exchange, Liberty Reserve charged customers a 1% fee for LR currency transfers and a "privacy fee" of 75 cents per transaction to hide Liberty Reserve account numbers, according to the Journal.

Will prosecutors move on to shutting down Bitcoin (BTC)? After all the parallels between BTC and LR are strong -- both are virtual currencies that use an exchange to convert legitimate currencies into electronic ones.

Patrick Murck, legal counsel for the Bitcoin Foundation, wants to avoid that comparison. As he told the Journal, "I think [the Liberty Reserve indictment] is just another giant, flashing warning light to bitcoin exchanges: If you're not compliant, there are some serious risks, both at the federal and state levels."

At this point, there is no evidence of Bitcoin being used for nefarious purposes that's as strong as what Bharara claims to have on Liberty Reserve. On May 28, he said that prosecutors had seized $25 million in 45 bank accounts around the world -- with "more to come."

Federal authorities did go after a part of the Bitcoin infrastructure earlier in May. They seized accounts of Mutum Sigillum, an intermediary of Mt. Gox -- the Tokyo-based Bitcoin exchange that controls 80% of the market. Mutum Sigillum accounts were seized because it had not "properly registered as a money transmitter with the Treasury Department," according to Bits.